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Waiting an Extra Day to Prove Support and Resistance
1-11-2004

Question

I reviewed my Silver trade this evening. I went back over your entry notes on pg 44 of your manual. Using a Sell Stop Order when the market touched 6.20 was really in anticipation of Support holding; however, it was probably not the market to do this type of entry.

Probably the late Entry method 2 would have been best, but I'm not sure how I can implement this during the day when I can't watch a trade chart. If you have any suggestions, please advise.

I'm thinking that I'm probably going to be limited to certain types of trades and may need to wait an extra day to prove Support or Resistance before placing my trade. What do you think?

Answer:

Honestly, you did nothing wrong, it was just a trade that went sideways. Let’s review the trade briefly and I’ll tell you where the boo-boo was.

We were looking for the market to break the mild support at 620 and head lower. Why 620? Because we had a two sessions in a row find support close to there AND by breaking 620 we would also be breaching the 5 day moving average line, which represents the weekly trend. Combine this with a very overbought market (RSI) that is beginning to slope downwards and I thought we had all the markings of a short term retracement.

However it didn’t turn out that way. Why? Primarily because it was a COUNTERTREND trade.

In hindsight I should’ve maybe given it a higher risk rating; however it did appear that all the pieces were falling into place…all except that trend piece.

Because of the extremely strong trend the market was only able to fall low enough to find our order, and not much further. As you can see from Thursday’s closing price, the market fell and then rallied hard again. This is the market’s way of saying “I don’t want to go there!” If we didn’t get whipped out of the trade so quickly, the update would’ve suggested a very tight exit stop as prices were appearing more bullish again.

This week looks like more of the same. Sure the market’s still overbought, but I wouldn’t be surprised to see higher prices still! Looking for resistance at 720 – 723 area, but we’ll see what happens.

And that’s the Reader’s Digest version of what happened. It’s just a part of trading. You didn’t do anything wrong regarding your orders; the trade just didn’t work out. It happens. If it makes you feel any better, I took a hit on it too. ;-)

Remember, countertrend trades are inherently more risky, but they can offer better entry potential. This is where the late entry part comes in. You wouldn’t use a late entry to initiate THIS trade, but if the market behaved as we hoped, we could’ve used a late entry to re-enter the market in anticipation of support.

Let’s say the market did do as we hoped and fell off to support at 594.50. Because we anticipated this to be a significant support level, you could have exited here and reversed your position taking the market long in anticipation of higher prices.

Entering before the market reacts allows you to keep your risk tighter than usual. You’ll see Tom do this all the time. He even keeps his entries tighter than I do. Whereas I might risk $200 to see if the trade works out, he’ll risk $50. The downside? His tighter stop might get him stopped out two or three times before the trade takes. So the end result might be the same, but it’s just a different way of doing things.

You don’t need to follow the market during the day to be able to trade this way. You can place your orders just like you normally do (ie. the night before) as we’re planning the trade based on what we expect support and resistance to do.

If you’re trading a smaller account, or if you’re not sure the resistance/support level is going to hold and cause the market reverse, then you’re better off waiting for the reaction before entering the trade.

Again using the silver example, if things went according to plan and the market fell off to 594.50, you could wait another day to see what happened next. If the market reversed the next day (as expected) then you could enter the day after ABOVE the high of the reaction day. Exit orders should go below the low of reaction day if feasible for your account.

If the low of the day is not feasible, find an intraday chart (www.barchart.com has them for free, just pull up the market you want and click on custom charts, or the 30 min chart for an intraday overview) and try to find a support level within the daily range from the intraday chart. Try to use the furthest support level you can afford to hide your exit stops.

This would now put us in a more predictable trend trade, after the market reacted to the anticipated support level; therefore we might have greater confidence of the trade working out.

Alternatively, you could attempt to enter the market within the daily range and place exit orders below the low. While this does not “make the market prove you right” it will help you limit the risk exposure somewhat. Again you could use the intraday chart to help you find an intermediate resistance level as a guideline for entering the trade.

You’ll see me structure trades this way when I’m fairly confident about the market direction, but a large range makes it difficult to get into the trade for smaller risk.

Note: you will not always be able to wait for the reaction for this type of trade. Sometimes the RRR will only make the trade feasible if you get on board early. The upside though is that there is usually less money at risk, so it’s not a big hit if the trade doesn’t work out.

Hope that helps some.

-Erich

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